Taking stock of the dollar’s global role
Peter Goodman looks at the dollar – and the growing dollar reserves of emerging market central banks — in today’s New York Times.
He captures the poles of the debate well. Ken Rogoff argues that it doesn’t make sense for poor countries to provide the US with a form of foreign aid by holding more low-yielding US assets that they need: “central banks know that holding these low-yielding Treasury bills is just an aid program to the United States.” Some analysts – a group that clearly includes me as well as Jim Fallows — question whether it makes sense for China to be financing, indirectly, real estate speculation in the US rather than schools in Shanghai.
“Investing money in the United States requires spending that much less on enormous problems at home, like pollution and a shortage of health care. By indirectly making mortgages cheap in the United States, China has helped foster the boom that saturated Miami with glittering condos even as tens of millions of Chinese live in dilapidated concrete block apartments.
Mike Dooley, on the other hand, argues that emerging market financing of the US is the best development program the world has yet devised. Emerging markets get a market for their exports; the US – uniquely – can run up big external debts without taking on a lot of currency risk because of the dollar’s global role.
There is a comparable debate over whether enormous central bank financing of the US is a “good” or a “bad” thing for the US. The growth of central bank dollar reserves has unquestionably provided the US with cheap credit. And many Americans are worried about the diminution of the dollar’s global status – in part because the shrinking international purchasing power of the dollar is a powerful symbol of America’s own shrinking global standing. It is hard to argue that it is “Morning again” in America when a dollar only buys 65 euro cents and, for that matter, when one dollar buys less than 1/100th of a barrel of oil.
On the other hand, there is – I suspect – concern about the extent the US has come to rely on other governments rather than private markets for financing. A country that relies on other governments for financing – and to recapitalize its banks – potentially puts own policy autonomy at risk. And the US has traditionally valued its policy autonomy.
The US would like to maintain the dollar’s global status – and not run up ever larger debts to the People’s Bank of China and the Saudi Monetary Agency. Right now, though, the dollar’s global status hinges in no small part on their willingness to hold dollars. Seriously. It really is hard to overstate how much the dollar’s current status as a reserve currency hinges on decisions made by the King of Saudi Arabia and China’s Communist party. That Saudis are on track to add $200 billion to their reserves, and most will be dollars. The Chinese are on track to add $600 billion to their reserves (and perhaps more), and a large share will be in dollars. Those two governments alone could finance the US current account deficit if – and it is a big if – all existing holders of US assets were willing to hold onto their claims.
There is an important subsidiary point to make here. Chinese financing of the US has been going up even as the United States’ importance to China’s own development has been fading. The Saudis and other oil-exporting economies are financing a growing market for their goods, but China isn’t. Its financing of the US right now just keeps the US market for Chinese goods from shrinking. China is – in effect – financing the US as a byproduct of a policy of holding the RMB down against the euro to support Chinese exports to Europe.
Goodman gave – in my view –a bit too much weight to the argument that the US has been a “remarkably solid place to put money, making it singularly able to attract savings.” That may be true over long periods of time. But it hasn’t been true over the past six years. The dollar is down something like 60% against the euro. US equities have underperformed global equities. And the high-tech wonders of American securitization technology – CDOs based on subprime debt – have recently made investors long for the comparative stability of Argentine bonds.
One of the reasons why the US now relies so heavily on central banks for financing right now is precisely that US financial assets haven’t been a good store of value. Goodman mentioned the slight fall in the dollar’s share of global reserves over the past few years, though he appropriately downplayed its importance. But he didn’t highlight what to me is the most important story of the past few years – the enormous rise in central banks dollar holdings.
The key change since 2000 isn’t the end of the dollar’s status as a reserve currency. It is the growing reliance of the US on central banks to provide a large share of the financing needed to sustain large ongoing trade and current account deficits. Private demand for US financial assets – relative to US demand for foreign assets — has fallen far faster than the US deficit. My estimates imply that central bank dollar reserve growth in 2007 exceeded the US current account deficit.
My estimates require making some Herculean assumptions about the currency composition of the reserves of China and the Gulf countries — the key countries that (I suspect) don’t report data to the IMF. They account for a growing share of global reserve growth – and thus a growing share of my estimate for dollar reserve growth. I assume that they hold a higher share of their reserves in dollars than the countries that do report, and that they have not diversified aggressively away from the dollar.
I could be off by up to $100 billion though and it wouldn’t really change the over all story. Central banks added way more dollars to their reserves than at any time in the past.
The following chart shows the dollar share of the countries that report detailed data to the IMF – along with the dollar share of global reserves that underlies my estimates.
Note that a slight fall in the dollar’s share of global reserves is consistent with a strong rise in central banks holdings of dollars; overall global reserve growth has been exceptionally strong.
I don’t think my assumptions are unreasonable. Nonetheless, I am planning to try to upgrade my estimates over the next few weeks, largely by separating out the assumptions for China and the Gulf central banks. If anyone has a few tips about the right assumptions to use, I am all ears. And if a few central banks decided to release a bit more data to facilitate understanding of their impact on the global flow capital, I would be very happy – even if their data proved that my estimates are a bit off.
I have always been puzzled why the Yen is not used more for reserves. Being the currency of the world’s second largest economy would seem to me to qualify it easily to be a strong second to the dollar as a reserve currency.
The yen’s low share stems in large part from the low-yields on yen bonds — this explains i suspect why the pound has gained on the yen recently. Central banks care, at least a bit, about returns.
"…while Americans were happy to borrow against their houses in order to consume imported goods. As the IMF points out, fundamental metrics suggest the dollar may have to fall further…" http://www.ft.com/cms/s/1/2c603fe2-1d96-11dd-983a-000077b07658.html
"…as long as Asian currencies are held down it will be impossible to resolve global imbalances, and the risk of a dollar crash, one day, will grow. The pressure mounts steadily: with US interest rates down at 2 per cent, China is now losing vast sums of money on its foreign exchange reserves. Verbal intervention on the US currency and euro is welcome – but it is time for verbal intervention on the rupee and renminbi as well…" http://www.ft.com/cms/s/0/41afd266-1d2a-11dd-82ae-000077b07658.html
I also liked the FT leader calling for verbal intervention on the rupee and renmini. I though prefer comments that provide one or two sentences of context explaining why the posted link is relevant to the theme of my post.
I think any discussion of whether something is "good" or "bad" needs to take place in the context of the alternatives. So suppose we agree that central bank financing of the US is a "bad" thing, what are the alternatives and why are the alternatives "better"?
Also, it is certainly true that the foreign policy of the US is constrained by the inflow of money from the Middle East and China, but *not* taking these inflows would also constrain US foreign policy. I don’t think that the US would be able to intervene to remain in Iraq with as little domestic opposition as currently exists, without external financing.
2fish — fair points.
Some of course might argue that more opposition to intervention in iraq from say wealthy americans who saw their home values falling b/c big deficits were putting upward pressure on interest rates (or who had to pay more taxes to avoid such an outcome) might have a salutary effect on the US political process. Some think it has been too easy for those who aren’t serving in military to defer the costs of Us involvement, distorting policy choices …
One other point is that by providing a huge amount of financing to the United States, the PRC has greatly reduced the risks of coming into conflict with the United States over Taiwan and pretty much eliminated any desire or ability of the US to destabilize the Chinese government. In talking about the amount that the Chinese government spends on pollution and the environment, those factors need to be considered. All of the anti-pollution spending goes to waste if mushroom clouds start popping up or if you have armed militia in the street because governmental authority has disappeared.
There have been a set of "grand bargains" between the United States and China over the last several years, and Chinese financing of the US has been part of that.
Do let me in on what those grand bargains are … might be useful knowledge. I sort of thought this whole system grew up more by accident than design, which would imply the absence of any grand bargain/ more risk of miscalculation.
bsetser: Some think it has been too easy for those who aren’t serving in military to defer the costs of Us involvement, distorting policy choices …
Perhaps, but the solution to this has been to minimize the number of people who are serving in the military and to minimize US causalities. The US military relies very heavily on high technology precisely to reduce US causalities, and hence reduce public opposition to wars. High technology is very expensive, and it’s easier for the US to spend Chinese gold than American blood.
There’s also an interesting quirk of human psychology that politicians and business people know how to exploit. If I take $5 from you, you hate me. If I give you $10, you’ll love me, despite the fact that I could have given you $15. Either way, I end up with $5 in my pocket. This example explains why there isn’t that much opposition in China to the extent to which China is funding the United States.
One thing to note is that while you have economists screaming about all of this, I don’t see too many other people getting upset about global imbalances, and if you look on the ground and see the ramificiations on individuals, it’s not hard to see why. Yes if the balances were resolved, then the Chinese peasant might get slightly better health care and lower inflation, but if it at the cost of losing their job, it’s a bad deal. You go to the American worker, yes he is upset of losing his job at the plant a few years ago, but he got a nice home equity loan, and he is working now at Walmart. Global imbalances might be bad in the abstract, but politics doesn’t happen in the abstract, and its hard to find people that are angry at the situation, and without anger, the status quo is going to be hard to change.
To bsetser: The basic bargain which evolved over 2004-2007 is that China keeps funding the United States uses whatever leverage it has with respect to Iran and North Korea and in exchange the US does not support Taiwan independence or attempt to destabilize the Chinese government. Also, the United States does not attempt to limit China’s rise to power and in exchange China does not attempt to challenge the US role as the sole superpower.
These things do evolve by accident, and there isn’t one moment you can see people shake hands or sign a formal agreement, but you can see these things coming into place bit-by-bit. It’s only afterwards that you see the quid-pro-quos and quiet understandings that evolve over time. There is a chance for misunderstanding, but given the amount and volume of informal contacts between the US and PRC, I think that it is relatively low for that leg. (There were some huge misunderstandings between the US and Taiwan and I think there are also some huge misunderstandings between the US and the Tibetan exile community but those are other issues.)
I don’t know about China, but I think it’s clear there’s been a US "grand bargain" with Saudi Arabia; just check out the first four minutes of The Kingdom — http://www.slashfilm.com/2007/09/27/video-first-four-minutes-of-the-kingdom/ — throw Israeli nukes into the picture and Iran trying to establish regional hegemony and it’s pretty easy to see how the US, with its satellite surveillance capabilities on loan, is able to keep the GCC in line…
Brad
how much do I stretch your thought when I read into your latest posts that a run on the dollar is happening right now and it is only partly hidden by insane efforts by the central banks of emerging countries?
2Fish: you can see these things coming into place bit-by-bit.
I don’t know if there is an informal "grand bargains" or just an emerging symbiotic relationship, but the rational for reserve accumulation has certainly evolved, from an initial need of reserves, and certainly continues to evolve now. Also this rational probably cannot be understood simply in terms of financial flows. These flows have to be seen as part of a wider balance between China and the US. The real economy matters, but the content of this or that account is probably secondary.
The situation could be changed from either side. Right now, it seems to be changing mostly from the US side, with its exhausted consumers. This will sooner or later influence the rational on this Chinese side as well.
> 2Fish: I think any discussion of whether something is "good" or "bad"
> needs to take place in the context of the alternatives.
I would think the discussion needs to take place in the context of what is a temporary artifact and what is the reality masked by it. The lack of alternative painless "solution" doesn’t mean that this one will work forever.
"Some analysts – a group that clearly includes me as well as Jim Fallows — question whether it makes sense for China to be financing, indirectly, real estate speculation in the US rather than schools in Shanghai."
Isn’t there an element of cherry picking what you think China’s money is financing? The fact is they’re mostly buying US government debt. I doubt the US domestic holders of the rest of the US government debt think they’re really financing real estate speculation. What’s so special about China’s holdings?
In a similar vein, Hillary Clinton thinks China’s money is financing US oil imports. Every one’s got an axe in the game.
Guest — China currently buys as many Agencies, including Agency pass-throughs, as Treasuries, so it isn’t a stretch to argue that China financed real estate speculation. And the state banks reportedly bought some more adventurous MBS with some of the money they managed for the PBoC. More generally, chinese purchases of US fixed income product of all kinds freed up US funds to chase yields, so in a general macro sense, there is an argument that Chinese other inflows financed the overall pattern of investment in the US economy. And that pattern included a lot of real estate investment from 04-06.
Alessandro — that is a bit more of a stretch that i am willing to make. Run would imply that American and foreigners with existing US assets were in aggregate looking to get out. We aren’t there yet. I do see a significant fall in the private sector’s willingness to finance the US, and perhaps even some official financing of small scale net outflows. but that hinges on a lot of estimates and I wouldn’t want to make too much of the financing of net outflows. I am though comfortable stating that net private inflows are currently way too small to support an external deficit of the scale the us is now running.
one of the grand bargains has to have something to do with the accommodation of immigrants: "…Those born in China and living in the United States increased from just 170,132 in 1970 to 286,120 in 1980, and on to 1,518,652 in 2000. By 2000, the Chinese population as a whole in the United States, at 2.7 million, had emerged as the largest Asian ethnic group and one that was increasing at a rate between four and five times faster than the growth rate of the total population of the country…" http://www.migrationinformation.org/Profiles/display.cfm?ID=219 - and the strongest influences on U.S. foreign policy may be respective diasporas in the U.S. "…Diasporic Iraqi groups and individuals played crucial roles in encouraging American military intervention in Iraq in 2003…" http://www.migrationinformation.org/Feature/display.cfm?ID=313
the unemployed auto worker is more likely to end up in the information industry, than a minimum wage job at Walmart: "…there are still broad gaps in how to best define the importance of documents, the costs of creating and using them, and the final "asset" value that they bring to an enterprise. The knowledge or information economy is obviously the broadest measure possible, with percent estimates as a contribution to GNP upwards of 65%…" http://www.mkbergman.com/?p=110 - and much of ‘the problem’ has be in the definition of ‘U.S. assets’
"…Against the euro, the U.S. dollar is around 25 percent undervalued." http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=aAZmZpIvJVXw
I sort of thought this whole system grew up more by accident than design, which would imply the absence of any grand bargain/ more risk of miscalculation.
Why do you suppose Cheney said deficits don’t matter, and invested his money outside of the dollar? I find it difficult that Greenspan didn’t see this coming.
Really enjoy this topic as a holder of precious metal I am interested in the strength of the dollar.
my precious…
"…Consumer prices rose 8.5 percent in April from a year earlier, the National Bureau of Statistics said today, after gaining 8.3 percent in March…" http://www.bloomberg.com/apps/news?pid=20601068&sid=aUbeikMLizQM
pretty soon all the dollar peggers with stronger underlying economies than the us and strong reserve growth will have 10% plus inflation; tis good to know economics sort of works. real appreciation is happening, albeit slowly.
nonetheless, tis clear that the rules of this blog aren’t particularly well-respected. posting links sans context/ w/o an actual comment is not something I particularly appreciate.
I want to return though to the core set of issues raised in the post — and to 2fish’s argument that there is an underlying (tho unexpressed) bargain between the US and cHina. i am unconvinced that such a bargain exists, but if it does, what could the US do to change it if it concluded that it wanted less cHinese financing and more chinese demand for us goods? How should we assess the relative costs and benefits of a world where the US is getting $800b plus in central bank financing? And does anyone want to take issue with my assumption that emerging market central banks that don’t report data to the imf hold a higher fraction of their reserves in dollars than emerging markets that do report data to the fund?
Anonymous: Diasporic Iraqi groups and individuals played crucial roles in encouraging American military intervention in Iraq in 2003…
In the case of American military intervention in Iraq, its hard to say who was using whom. One issue is that at least with Chinese and Vietnamese (and I’m pretty sure with Iraqis) there are huge splits within the diaspora community. Trying to get a group of ethnic Chinese to do something, you’ll quickly find disagreements in origin, age, politics, dialect, class, political outlook etc. etc.
However, one of the major demographic trends is that new ethnic Chinese immigrants tend to be from the PRC rather than Taiwan, and I’ve seen situations where that mattered. One example was around 2002, when Tom DeLay invited Taiwan president Chen Shui-Bian to attend a baseball game with him. It turned out to be quite an impolitic thing to do.
The other thing that I’m seeing is the formation of a "global elite." It turns out that the people that run the planet tend to go to the same universities (i.e. Harvard), attend the same conferences and think tank functions, and have world views that are quite similar.
Part of the grand bargain that happened in 2004-2007 was mainly not to overturn agreements and understandings that had been made earlier. In the 1940’s, Roosevelt came to some understandings with King Saud and Chiang Kai-Shek. In the 1970’s, Nixon and Kissinger came to some understandings with OPEC and Chou En-Lai. Bush the younger came in with a domestic and foreign policy agenda that involved revolutionary change. He wanted to vastly reduce the size of the US Federal government while at the same time making the world safe for democracy which would have involved eventually overthrowing the House of Saud and the Chinese Communist Party and replacing them with liberal democracies. Iraq was merely the first step in the global march of freedom. The trouble was that what they were doing made no economic sense, but the people making these plans weren’t listening to anyone with any economic sense. By 2005, it became pretty obvious that all of these massive plans were coming to nothing, and at that point the Bush administration changed their policies to go back to the understandings that had been reached in the 1970’s.
Anonymous: the unemployed auto worker is more likely to end up in the information industry, than a minimum wage job at Walmart:
I’m not sure that this is the case. Manufacturing jobs have been lost. IT jobs have been created. However, I just don’t see unemployed auto workers becoming computer programmers. I’d be really happy if this were the case, but among computer programmers, none of them were former auto workers. One problem is that in order to become a skilled computer programmer, you need at least four years of training. When the plant closes, you just aren’t in a position to get a masters in computer science.
Dr. Setser, in line with your 1st chart I have read elsewhere the following statement: "According to International Monetary Fund (IMF) statistics, the world’s total foreign exchange holdings increased from $1.4 trillion in 1997 to $6.4 trillion last year, an average annual increase of 16.4% - compared with a 7% annual increase in Gross World Product." Is the world’s total foreign exchange holdings a reasonable proxy for a measure of global supply of money/credit?
If so, the quantity of money & credit in the world has more than quadrupled in the last 10 years while the number of things to purchase has only doubled roughly.
China didn’t force the Fed to fail toregulate junk loans with zero downpayments based on the false idea that home prices will rise forever. Zero downpayment has nothing to do with interest rates and treasury/agency market.
This is again a failure of USA authorities, nothing to do with China.
Other USA failures causing imbalances:
- urban sprawl, SUV, no public transportation infrastructure increasing reliance on big oil
- lack of energy policy increasing reliance on big oil
- out of control Iraq war spending blowing up the budget for otherwise useful actions
- ultra protectionnist "free trade" treaties (think intellectual property on drugs) distorting real "free trade" which would otherwise be beneficial.
China has nothing to do with this. And BTW nobody cares with 10% inflation in an economy growing like China does.
"…Food prices surged 22 percent in April from a year earlier, giving China the highest inflation rate among the world’s 10 biggest economies and posing a threat to social stability as the nation prepares to host the Olympic Games. "The inflation situation is very serious and the government needs a clear solution," Li Wei, an economist at Standard Chartered Bank Plc in Shanghai, said earlier…" http://www.bloomberg.com/apps/news?pid=20601068&sid=ajvV.5V5PNnM&refer=home
Would reversing the Bush tax cuts eliminate the current account deficit? What about ending the ongoing wars in the middle east? Or is the scale and scope of this problem much more expensive than that?
While I enjoy Twofish’s post hoc explanations for events, I don’t actually buy his theory of grand bargains. Instead I am more focused on what policies the US can adopt to fix before an adjustment is forced upon the US.
Guerby: And BTW nobody cares with 10% inflation in an economy growing like China does.
The trouble with 10% inflation is that it can quickly become 20% inflation. Right now the big debate is "money versus pork" which the debate over whether the inflation is due to monetary policy or food supply constraints. The reason that the Chinese government is moving rather slowly to deal with the inflation is that the pattern (rising prices in food, non-rising in non-food) isn’t bad for farmers, and actually reduces social stability problems.
(BTW, you can get well formatted comments by single spacing between paragraphs rather than double spacing.)
re: (BTW, you can get well formatted comments by single spacing between paragraphs rather than double spacing.)? - anybody else get this result? another question would be how to make links link…
Algeron — reserve growth can be sterilized so it doesn’t correlate with money growth perfectly, though rapid reserve growth certainly creates pressures that unless offset will produce money growth.
Laurent. The (lack of) a US energy policy is certainly a US policy choice; hands off regulation of mortgage brokers was another. That though doesn’t mean that exchange rate pegs didn’t have an impact — they shape the profitability of investment in manufacturing across a range of countries, and lowering treasury yields reduced the financial costs of a host of US policies.
2fish. I clearly didn’t get the memo that all harvard grads should write nice things about SWFs ’cause they are a big source of i-banking and PE fees …
finally, I intend to start taking down comments that post random links that I do not find helpful; this discussion started off in an interesting way and then veered a bit off topic. I would like to see it return to some of the questions I laid out in an earlier comment.
if you bothered reading the comments and articles behind the links you would realize the material does respond to your questions - "helpful" or not.
Brad
honestly, if harvard grads didn’t have those thoughts without being specifically told, harvard has done a terrible job - there goes another of my fantasies; the untarnished harvard
BTW, China hiked its bank reserve requirements again and a major earthquake has hit the sichuan province, not a very good year for asia, natural disasters and all.
What do people think about Bush’s thoughts on food prices? Blaming Indian and Chinese middle classes, not smart, not that that’s news when it comes to the guy.
maybe you should implement a comment policy?
http://bigpicture.typepad.com/comments/2008/05/comments-trolls.html
http://www.boingboing.net/2008/03/27/boing-boings-moderat.html
comment policy is that i appreciate civil, on-topic comments and value a true dialogue;
comments are comments, not posted links. I cannot read people’s minds and won’t try;
links are preferred to long excepts of text when the material in the link is relevant to the comment.
now back to substance — what is the right assumption to use for the dollar’s share of non-reporting emerging economies reserves? does anyone have a good sense? and how should we in the us assess the benefits/ costs of the $’s reserve currency status?
bsetser: what is the right assumption to use for the dollar’s share of non-reporting emerging economies reserves?
Something one can do is to work things from the borrower end rather from the lender. Start with the total world stock of US treasuries and agencies and the subtract the amount that is known not to be in emerging markets. This will give you an upper limit for the amount of treasuries and agencies which are in emerging markets. If you then start subtracting known stores of these securities, you should be able to see the size of the unknown value.
bsetser: how should we in the us assess the benefits/ costs of the $’s reserve currency status?
Owing money in a currency you control is always a good thing. Also, one should assess it in terms of the alternatives. The only other currency out there that could possibly be a major reserve currency is the Euro. Even if the US decided that it didn’t want to be the worlds reserve currency, it would take decades to unwind all of the dollar positions. There is a historical analogue in Pound sterling.
bsetser: I clearly didn’t get the memo that all harvard grads should write nice things about SWFs ’cause they are a big source of i-banking and PE fees …
That’s because it really doesn’t matter if you write nice things or not about SWF’s. If I-banks and PE don’t get their money from SWF’s, they’ll get it from somewhere else. But there is a set of shared cultural values that you do get if you go to elite schools in the US. For example, most Harvard graduates think that more material wealth is a good thing, and not too many think that its a good idea to blow yourself up for a chance at paradise in the afterlife. Not that it isn’t a bad thing, but it will cause problems if large numbers of people feel left out of the system.
bsetser: i am unconvinced that such a bargain exists, but if it does, what could the US do to change it if it concluded that it wanted less cHinese financing and more chinese demand for us goods?
The first is easy. Recognize Taiwan and Tibet as independent states and start bombing Shanghai. This would end any desire of China to fund the US, and move the trade deficit to zero. It would also start world war III in the process. The second is also easy. You could do it by selling China, the most advanced US fighter jets and an aircraft carrier battle group which I’m sure the PLAAF and PLAN would love to buy.
I’m proposing ridiculous things here to point out how much the US-China economic relationship is constrained by non-economic forces.
bsetser: How should we assess the relative costs and benefits of a world where the US is getting $800b plus in central bank financing?
I don’t think that it is useful to try to come up with a single index. What I think is more useful is to go to different people, and see what the costs and benefits are to that person, and different people will have different costs and benefits.
Stephen Jen offers a useful framework in assessing the costs/benefits of the $’s reserve currency status: "…it may be useful to consider three different types of SWFs, based on the sources of the accumulation of official reserves/SWFs: (1) oil and other commodities; (2) goods or C/A surpluses; and (3) capital inflows…" http://www.morganstanley.com/views/gef/archive/2008/20080512-Mon.html
T. Boone Pickens thinks it’s the other way around; he believes we’re giving $600bn/year to the "enemy," which is a wealth transfer that in his mind doesn’t make any sense, and so that’s the global imbalance that needs to be corrected first — he just doesn’t see any leadership there in that regard http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a8Roxzn8p.bI
"…The result is an inevitable series of market accidents and policy mistakes … The solution is not simply a U.S. solution. Other consumers around the globe need to step up to the plate, in particular in China and India. We need to see a handoff from what is tiring U.S. consumers who are subject to headwinds to consumers in emerging countries who are empowered by a growth in the middle class, higher income, larger wealth, and legitimate aspirations. But as these countries get richer and consume more, they also put pressure on commodities, so it’s a very complicated world we live in right now…" http://www.businessweek.com/magazine/content/08_20/b4084063533815.htm
Brad,
Large growing dollar reserve holdings are not good for the world economic system. It’s a sign of imbalance. These very large dollar currency reserve holdings (and US treasury purchases) by many nations are just a by-product of an effective effort to de-value each nations currency against the dollar. Currency de-valuation provides many nations (in particular, China and India) with an unfair competitive advantage, and is the root cause of US economic woes and the rise of inflation. This is because currency devaluation actually discourages truly efficient per capita production practices. The problem this causes for the US is that the currency pegs make investment in the US less attractive and keeps US export prices relatively high. This keeps sending the US into economic slowdowns due to low domestic investment. The result is the fed steps on the accelerator to stop the economic slowdown, increasing liquidity in the US, but also increasing the capital out flow of the US searching for better investments. The dollar flows out of the US but can’t get back in sufficiently via US exports due to foreign government’s efforts to keep the dollar strong by growing big pools of dollars to keep their currency relatively weak. This eventually sends the US into another economic slowdown as the fed let’s off the accelerator and raises interest rates. The actions that governments take to maintain these pegs short circuit the self correcting nature of the economic system via currency. The increasing frequency of US boom and bust cycles is just one symptom. The easy credit condition resulting in the US housing boom and bust is another. The irony is the US encouraged this situation via the “strong dollar policy” during the Clinton administration.
"The yen’s low share stems in large part from the low-yields on yen bonds — this explains i suspect why the pound has gained on the yen recently. Central banks care, at least a bit, about returns."
I wonder - the real (inflation-adjusted) return to yen-denominated assets has not been that bad.
I think Michael Dooley and T. Boone Pickens are right.
What happens to the share of the dollars in reserve assets after adjusting for exchange rate changes? For example, what would your graphs look if the euro had stayed constant at $1.20?
An analogy I like - the U.S. is being force-fed foreign lending, like you stuff a goose to make pate de foie gras. It won’t end well, and short-sighted (enabling) fed policies will only make things worse.
Twofish: Owing money in a currency you control is always a good thing.
… but being dependent on future inflows is not a good thing, especially if these flows are decided by a Saudi King and the Chinese communist party.
Twofish: The only other currency out there that could possibly be a major reserve currency is the Euro.
You’re missing 1 logical step: why does this reserve accumulation need to happen at such rates as described above?
I am saving to buy my first home. Will I have to pay more because of Chinese policies? What does it imply in terms of economic distortions? Is that good or bad?
FG: You’re missing 1 logical step: why does this reserve accumulation need to happen at such rates as described above?
Because the US is fighting a major war and the wealth needed to fund that war has to come from somewhere. Since it’s politically bad to take the money from obvious places, the wealth comes from non-obvious places.
One other factor in the case of China is that China needs to save massively in order to face the demographic crunch that is going to happen shortly.
FG: I am saving to buy my first home. Will I have to pay more because of Chinese policies? What does it imply in terms of economic distortions? Is that good or bad?
Actually, you are going to end up paying a lot less. As far as economic distortion, I really don’t like that concept because it assumes that there is some "undistorted" situation when there isn’t. As far as good or bad. Good or bad for whom? Overall what is happening is that there is some Chinese worker that is saving for retirement that is giving you your money for your house with the expectation that you are going to pay the money back to him when he gets old.
Twofish: Overall what is happening is that there is some Chinese worker that is saving for retirement that is giving you your money for your house with the expectation that you are going to pay the money back to him when he gets old.
Yes, but, the Chinese worker took your job, because the Chinese government forces him to accept 7 times less pay, so you can’t pay him back.
FG: I am saving to buy my first home. Will I have to pay more because of Chinese policies? What does it imply in terms of economic distortions? Is that good or bad?
For awhile you will get lower house prices, with higher interest rates, and more money down. So you might have to save longer. And you will need very good credit.
Rather than having sustained growth, we are having more frequent boom and bust cycles. Do you like roller coaster rides? We are going to see continued inflation until slower growth finally takes hold in China and India.
"There is a comparable debate over whether enormous central bank financing of the US is a “good” or a “bad” thing for the US."
Foreign (CB or private) financing of the US’ (or any country’s) current account deficit can in principle be considered "good" for the financed country: it is exchanging real stuff for printed paper, or promises to give more printed paper in the future. It’s even better if the financing is provided in the indebted country’s money as is the US case: all depreciation risks are assumed by the lender.
In the long run, however, if that financing is used for further developement of a living arrangement that has no future (suburban housing), the US would have been better off if no financing had been given to them. Same case as an addict: if he uses all money given to him to buy drugs, he’d be better if he got no money.
"The US would like to maintain the dollar’s global status – and not run up ever larger debts to the People’s Bank of China and the Saudi Monetary Agency."
The only way to not run up ever larger debts to foreigners (whoever they be) is to cut the current account deficit, which can be achieved thru either of the following possible Fed monetary paths:
a. Volcker’s style, causing a deep US recession, in turn causing US imports to drop drastically due to demand failure
b. Ben’s style, causing a (further) plunge in the dollar value, in turn causing US imports to drop drastically due to foreign goods becoming prohibitive to Americans.
Unless foreign holders of dollars and dollar-denominated debt do not care in the least about maintaining the value of their investments, path b. should lead to a the US dollar losing its status as international trade and reserve currency.
"Right now, though, the dollar’s global status hinges in no small part on their willingness to hold dollars."
The global status of ANY currency (fiat or even metal) has and will always hinge SOLELY on the willingness of global players to accept and hold it. See what happened to silver relative to gold after central banks worldwide decided to demonetize it in the 1870’s. And the main factors that prompt those players to do that are the perceived intrinsic usefulness and scarcity of the currency.
Real Think — methinks we need a "new economics" for reserve currencies just as the .coms created the new economy. In this new new economy, Ben style policy REINFORCES the dollar’s global position, as the pressure on the dollar to fall is offset by the world’s central banks leading to an intensification of reserve growth and dollar holdings.
That sounds strange — no Paul volcker policies, yet a rise in the willingness of the official sector to hold dollars — but it seems to fit the facts …
Brad, should I construe your last comment as sarcastic, meaning that this "new economy" is built on as shaky grounds as 10-yr-ago .com, and that it will end juat as badly?
Because as you have shown time and again, latter day CB’s reserve growth is most unwise. So, the US is betting that their foolishness has no upper boundary.
BTW, your colleage Benn Steil seems to think that the old economics is alive and well and will eventually assert itself. I dissent though on the euro’s fitness to take over.
http://www.cfr.org/publication/16094/how_the_rise_of_the_euro_threatens_americas_dominance.html
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